Ben’s Portfolio update end of August 2024

SlowAndFast · September 7, 2024, 8:27pm

Ben’s Portfolio update end of August 2024

Returns and portfolio holdings:

	Portfolio	Notes
2020	63.6%	Since May 12, 2020, when I started this portfolio with over 40 companies, mostly holding large cap tech & FAANG, but also some high-growth SaaS.
2021	13.1%	Discovered Saul’s board in February 2021 and started concentrating to 16 companies through December 2021.
2022	-60.7%	Concentrated a bit more through July 2022 from which point I started posting my monthly updates on Saul’s board, holding about 12 or fewer positions.
2023	77.8%

2024	YTD	Month
Jan	5.9%	5.9%
Feb	17.5%	10.9%
Mar	13.6%	-3.3%
Apr	6.4%	-6.4%
May	6.8%	0.4%
Jun	21.0%	13.3%
Jul	7.0%	-11.6%
Aug	12.6%	5.3%

Time-stamp: August 30th, after market close.

These are my current positions:

	Aug 2024	Jul 2024	First buy*
Nvidia	23.6%	24.4%	5/13/2020

Datadog	13.7%	14.6%	5/13/2020
Cloudflare	13.0%	13.0%	11/2/2020
Zscaler	10.6%	10.1%	3/4/2021
Crowdstrike	9.5%	9.6%	5/13/2020
Snowflake	9.0%	10.9%	2/8/2021

Monday	7.0%	6.4%	9/13/2021
Axon	5.6%	3.5%	4/2/2024
TradeDesk	3.8%	3.4%	5/13/2020
Samsara	3.6%	3.5%	1/8/2024

Enphase	0.7%	0.7%	5/15/2020

*held through today

Time-stamp: August 30th, after market close.

Company comments:

Cloudflare:

Key insights:

Good revenue growth at 30% YoY and 6% QoQ. Expecting back half QoQ acceleration to 7.5% in Q3 and 7% in Q4 which will lead to slight YoY growth deceleration to 27% by Q4, while I’d like to see it closer to 28% in FY25. YoY net new revenue adds are also on track.
Cloudflare seems to reposition its revenue structure away from subscriptions and towards consumption, which I think would be a good move in preparation for the age of AI. The way they do this is negatively impacting NRR and so NRR isn’t really a good metric that reflects how their business is doing. Same goes for RPO and cRPO.
The highlight of the report was an incredible 13000 new customer adds this quarter, which is around double what they typically added in any quarter during the last few years.
Again very strong profitability this quarter with operating income margin expansion of 7.6% YoY, to a record 14.2%, from 6.6% in 2Q23.

Cloudflare reported fiscal Q2 2024 on 08/01/24. Revenue came in pretty much exactly as I had expected at $401M (5.9% QoQ, 30.0% YoY) versus my expectation of $402M (6.1% QoQ, 30.3% YoY), beating their guide by 1.8%. Their Q3 guide was also exactly as I had expected at $424M (5.5% QoQ, 26% YoY), which should bring them to $431M (7.5% QoQ, 28.4% YoY) if they can beat it again by 1.8%. This, together with their new FY guide, raised by 0.5%, points to back-half QoQ revenue growth acceleration, where I’d expect Q4 QoQ revenue growth around 7%, which would lead them to beat their current FY guide by 0.8% - not crazy. With that, QoQ growth would be going from 4.4% in Q1 and 5.9% in Q2 to 7.5% in Q3 and 7.0% in Q4. Note, a 6.8% QoQ run rate compounds to 30% YoY growth. So while YoY growth rates will likely drop below 28% by Q4 (due to slightly tough comps), I’d expect it to stay around 28% for FY25.

Coming back to 2Q24, net new revenue increased by $22M QoQ and $93M YoY, which is a nice step up. Here is the YoY net new revenue plot including my projection for Q3 and Q4:

Similar to what I discussed with Datadog (here: Reflecting on Consensus - #2 by SlowAndFast) you can nicely see how they got a revenue boost after COVID, followed by a 2Q23 that fell below the trend line, but then quickly picking up the speed again in Q3 of last year. 2Q24 sequential net new revenue also grew nicely, by 39% QoQ and catching up from a seasonally weaker Q1. With that, I’d say Cloudflare is well on track with revenue growth, despite what seems to be a tough environment according to the CEO “This wasn’t an easy quarter, but we continue to execute and deliver strong results. While I think we benefit from being in must have, not a nice to have, we still had to fight for every deal as the IT buying environment continues to be challenging. But our investments in go-to-market improvements are showing dividends. Turns out when you have the right players on the field, you can still play and win even in the rain”.

Let’s dive into secondary metrics of this Q2 as there are some interesting developments in the land-and-expand motion. To start, NRR, which I wanted to see rebounding to 116%, from being at 115% the previous two quarters came in at only 112%. Management had this to say about this decline: “The decline in DNR was driven by slower net expansion in our larger customer cohort, increased platform deals in the form pool of funds contracts which reduce friction to adoption across our product portfolio, but can impact the shape of revenue recognition as well as deferred revenue and current RPO, especially for existing customers that transition into this structure. And anniversarying the price increase to our Pro and Business payable plans last year. For the next several quarters, we expect new customers to contribute a higher percentage of our overall year-over-year revenue growth, similar to the second quarter.”

And later in the Q&A:

“the decrease was driven by slower net expansion, but it was also impacted by what Matthew described, a large pool of funds deal. So, as we entered this fiscal year, we’ve entered into several of these pool of fund deals. They’re all very large in nature. The biggest ones, anywhere between $40 million to $60 million of total contract value. As a matter of fact, 4 of our top 10 customers are now pool of funds customers. And these pool of fund deals are generally built monthly as compared to an upfront annual billings, and they tend to have a longer durations. So, most of these contracts are north of three years. And as a result, the financial impact of these pool of fund deals is very different, it’s very different on revenue and it’s different on the current RPO and it’s very different on deferred revenue. And if it’s an existing customer that transitions, it also impacts DNR.”

I wish they were a bit clearer and quantitative about explaining the impact on NRR. For example it would have been helpful to give an adjusted NRR number that takes out this pool of funds deal effects, but I guess this might become a messy calculation and they’d have to keep carrying this adjusted NRR forward into future quarters. Also, what they are essentially saying is that new customers immediately buy more products upfront, which is great for revenue, but leaves less products to expand into. So maybe, while Cloudflare is undergoing this transition, NRR isn’t really a good metric that reflects how their business is doing. Interestingly this discussion also seems to indicate that Cloudflare is at least partly going in the direction of a consumption based business. I can imagine that this is part of a strategic move to better position them for the new AI era.

Speaking about AI, “Today, we have inference-tuned GPUs live in 167 cities worldwide, making us we believe the most global cloud inference solution, and inference requests powered by Cloudflare AI increased more than 700% quarter-over-quarter.” So it is great to see that edge-inference shows some clear signs of traction.

So while this quarter was a little bit hard to judge from the expand side, the land side did really well: They added an incredible 13000 new customers this quarter, which is around double what they typically added in any quarter during the last few years. In fact, when I calculated that number, I first thought I had made a mistake in my spreadsheet as I couldn’t believe such a strong increase in new customers. Now, to take away a bit of the thunder here, management said in the Q&A that they had a one-time benefit as they migrated billing platforms and had a catch up. But overall, the strong customer growth was driven by the increase in developers on their Workers platform, which increased 20% in just the last four months, from a large base of 2 million active developers, to 2.4 million.

Large customer growth was a little bit weaker than I had hoped for, although it is good to see QoQ growth accelerate from 4.4% in Q1 to 5.8% in Q2. So while they added 168 new large customers this Q2 I’d like them to set a new record of more than 212 new large customers in Q3. Let’s see …

Also impacted by their transition to pool of funds deals, RPO and cRPO grew a little bit less than I had expected, at 5.8% QoQ and 4.3% QoQ. With that cRPO YoY growth dropped to 26%, but is suffering from tough comps, just like revenue YoY growth is going to suffer some tough comps in the next couple quarters. So cRPO YoY growth is consistent with my expectations for YoY revenue growth dropping below 30% in the next 3 quarters, after which comps will be easier again and, provided that QoQ growth rates stay around 7% going forward, YoY revenue growth should then reaccelerate back to around 30%.

Profitability metrics were great this Q2. Operating income was $57M, versus my expected $45M, resulting in a 14.2% operating margin, which is up from 6.6% last year and 11.2% last quarter. So great margin expansion, mostly driven by driving S&M expenses closer towards their long-term operating model and despite increasing R&D spend by 11% QoQ. S&M is now at 37% of revenue, down from 41% last year and 41% last quarter, with a long term goal of reaching 27-29%. With that, overall operating expenses dropped to 65% of revenue, from 71% a year ago and 68% last quarter. Net income margin also expanded further, to 17% of revenue, up from 11% last year and 15% last quarter. They also managed to achieve an FCF margin of 10%, just as I had expected.

Datadog:

Key insights:

Good Q2 revenue growth at 27% YoY and 5.6% QoQ despite leap year headwind. Expect sequential growth will continue to accelerate in H2 to 6.3% in Q3 and 7.1% in Q4. That’ll bring YoY growth down to 25% where I expect it to be durable. Caveat: significant uncertainty to the up or downside because Datadog is a consumption business and less predictable than subscription. But durable 25% YoY growth would be great for compounding revenues.
Land and expand motion on track, with some lumpiness in large customer growth and solid overall customer adds. Expansion with existing customers was great with NRR firmly establishing a bottom and expected to go up in coming quarters and multi-product adoption very strong. Implied average annual contract values continuously become stronger.
Profitability margins took a hit this quarter with increased operational expenses in headcount and DASH conference to continue to fuel innovation and sales & marketing.

Datadog reported Fiscal Q2 2024 on 08/08/24. Top-line revenue came in at a solid $645M (5.6% QoQ, 26.7% YoY) matching my expectation of $647M (5.8% QoQ, 27.0% YoY) and beating their guide by 3.7%, similar to Q1. It is good to see them re-accelerate QoQ revenue growth from their seasonally slower Q1 where they grew only 3.7% and I expect this QoQ revenue growth acceleration to continue through Q3 and Q4. Here, the question I have is exactly how much will they accelerate QoQ growth? Looking at their guides, I’d expect them to grow revenue by 6.3% sequentially in Q3, beating their Q3 guide by again about 3.6%. Then looking at their new FY guide, which they raised by 0.8% this quarter, I’d expect even more sequential growth in Q4, which has also typically been up from historical Q3. Why? Because without beats, Q3 guide is for 2.6% QoQ growth and to get to the new, raised FY guide of $2.63b, they’d have to grow Q4 revenue by 7.5%, implying that they expect more sequential growth in Q4 than in Q3. Assuming a typical beat of their Q3 guide and another raise and beat of their FY guide, my baseline expectation would be for YoY growth to stay closer to 25% in Q3 and Q4, which is slightly down from my previous expectation of 27%. But of course there is a significant uncertainty here that it could go better or worse; as their CFO said on the call, regarding usage through July and into August: “what we’ve seen since the quarter, as we mentioned, is a continuation of better usage trends relative to the comparable period last year . So more of the same. And in our guidance philosophy, it hasn’t changed. We take those trends as much information as we have and applied discount and conservatism given that we don’t control the consumption of our clients, we observe it .”

Secondary metrics were mixed. Starting with RPO, I found it weaker than I had hoped for as it only grew 3.5% QoQ. At least it bounced back from Q1 where RPO was actually down by 6% sequentially, so the fact that it went up again tells me that there at least isn’t anything systematically wrong, other than what management keeps telling us that RPO and billings are lumpy. Speaking about the latter, billings was strong, growing 7.9% QoQ, in comparison to 1.8% in 2Q23 and -11% in 2Q22. It also bounced back from a sequential decline in Q1, where it dropped almost 15%. It is also worth pointing out that both cRPO (35% YoY growth) and billings (28% YoY growth), are growing faster than revenue growth, which is currently at 27% YoY.

Next, the land-side of their land-and-expand motion was also mixed. Total customer growth was good, adding again 700 new customers, just like in Q1 and showing some improvements over 2023, where, aside from the inorganic Q1, net adds were at 600, 700 and 500 in Q2, Q3 and Q4. So here I am looking for them to continue adding 700 or more customers in their upcoming quarters. While total customer growth was good, I was a bit disappointed at large customer growth. After a very weak Q4 (60 adds) they did very well in Q1 (150 adds) and I was hoping for continued momentum here. They did add only 50 large customers in Q2. In fairness though, Q2 seems to be a seasonally weak quarter for large customer adds, where looking back all the way to 2020, net adds dropped from Q1 to Q2 in every single year by as much as 76% and as little as 8%. And the fact that it dropped by 67% from Q1 is probably also partly because Q1 was so strong. So I think this was more of a timing effect. If true, I’d expect them to add at least another 100 new large customers in Q3 and hoping for more.

Another way to look at large customer adds is to look at TTM, that is the sum of the net adds over the last four quarters for each quarter they reported:

I think there are two ways to interpret this data: First, one could think that net new adds have stabilized in the last three quarters (green trend line), which would be a good thing. Second, one could think that 4Q23 was just an outlier and the trend of declining adds has continued through 2Q24 (red trend line). So I’ll be watching the net new adds they report in Q3 to get some more clarity here. If they indeed manage to add 100 new large customers, that would drop the TTM number to 360 which would be a continuation of the red trend line. If they can manage closer to 150 new large customers, that would be a continuation of the green trend line. Most likely the reality will be somewhere in between, as it’ll get harder and harder to add more large customers (kind of like the law of large numbers …). By the way, I don’t think that is necessarily a bad thing as it seems like a natural progression for any successful company. It is worth watching though as it’ll tell us more about where Datadog is on its customer acquisition journey and as I said above, if they were to add less than 100 new large customers in Q3 it would raise new questions about why the trend is suddenly getting worse.

So while the land-side results were mixed as discussed above, I thought the expand-side did really well: Let’s start with Net Retention Rate (NRR). NRR remained in the mid-110s percent in Q2, just like in Q4 and Q1. That not only firmly establishes a bottom, but the call-commentary made it clear that it is actually trending up again: “Our net revenue retention percentage was in the mid-110s in Q2, similar to the past couple of quarters. But remember, this is a trailing 12-month measure, and we’ve seen an increase in recent quarters as we look at the NRR quarterly trend.” Also, their gross revenue retention rate remained stable in the mid- to high 90s percent. Continuing with great news, their customer’s multi-product adoption trend picked up speed again in Q2, where the percentage of customers using 2+, 4+, 6+ and 8+ products sequentially increased to 83% from 82%, 49% from 47%, 25% from 23% and 11% from 10%, respectively. Especially the increase in the 4+ and 6+ cohorts is noteworthy as they increased not by only the typical one percent, but two percent. So NRR and multi-product adoption tell a clear story that the expand-side is doing really well. Connecting customer and revenue numbers, we can also calculate an implied annual contract value (ACV), which is four times the quarterly revenue divided by the number of customers in the corresponding quarter. This metric also tells a clear story of how customers are becoming more valuable over time. Following just the evolution in Q2s since 2019, ACV went from $38k → $46k → $57k → $77k → $78k → $90k in 2Q24. This trend certainly helps with offsetting the slowing customer growth rates. It is also nice to see how they picked up the pace again after a relatively slow 2Q22 to 2Q23. So ACV, NRR and multi-product adoption tell a clear story that the expand-side is doing very well.

Finally, coming to profitability. Profitability margins took a hit this quarter, mostly because $11M in expenses related to their DASH user conference, but also because of increase operating expenses in S&M, R&D and G&A due to headcount investments. With that, operating margin was 24.4%, up from 20.9% last year and down from 26.9% in Q1. Adding back in the one-time cost of the DASH conference would bring the margin back to 26.1%, so I discount that as a one-time profit margin headwind and expect it to expand again in Q3. That margin headwind extended through net and free cash flow margins which were all down sequentially. Net went to 29.4%, up from 24.6% last year and down from 32.1% in Q1. FCF went to 22.3%, down from 27.8% last year and down from 30.6% in Q1. On the bright side, I expect the expense for their DASH user conference and hiring in S&M and R&D to drive future revenue growth, so I am fine with it as long as margins will continue to expand in Q3.

Snowflake:

Key insights:

Q2 revenue growth was on the weak side, but had a leap year impact. I’m ok with it if they can catch up a bit in Q3 and deliver about $57M net new revenue.
Secondary and forward-looking revenue growth metrics were very strong:
NRR continued to stabilize
RPO grew an astounding 47.8% YoY, the strongest YoY growth in 7 quarters.
And customer growth (large and overall) was very strong, while G2000 customer growth seems to hit a point of saturation.
Data sharing metrics were very strong (again!) and has reached around 30% of all customers, nicely demonstrating Snowflake’s network effect moat.
With all those strong forward looking metrics, why are revenue guides, factoring in typical beats projecting revenue growth to slow to 26% YoY from currently 30% in the next 3 quarters? RPO growth, which is a forward-looking metric had a low of only 23% YoY growth in Q3 last year and I am expecting this slow-down to be reflected in revenue growth sometime within about the following 2 years. So it makes sense to feel this slowdown in revenue growth 4-6 quarters later.
Good news is that RPO growth strongly accelerated after that Q3 last year, so I expect YoY revenue growth re-acceleration starting again in about 4 quarters.
Why then wait and stay invested for this time and potentially pay a significant opportunity cost? Good question and something I need to ponder more, but my guess is that the market will sniff this out much sooner, so we might be only looking at one or two more tough quarters. And it all could start to accelerate earlier since Snowflake is a consumption business and not a subscription business.

Snowflake reported fiscal Q2 2025 on 08/21/2024. Revenue was $829M (5.0% QoQ, 29.5% YoY) versus my expectation of $840M (6.4% QoQ, 31.2% YoY). This was certainly on the weak side given that they added only $40M in sequential revenue, down from $50M last year in Q2. On the other hand, Q1 had an extra day in the quarter which created a somewhat tough comp for Q2 QoQ growth. Indeed, Q2 QoQ growth would have been closer to 6.2%, adjusted for the extra day in February. Consequently, because of the lower revenue dollar number, their Q3 guide was also lower than I had expected at $853M (2.8% QoQ, 22% YoY) versus my original expectation of $878M (4.4% QoQ, 26% YoY). With that, I’d like them to catch up a bit in Q3 and deliver about $57M net new revenue, which would be in-line with previous Q3s. To do that, they’d have to beat their Q3 guide by 4% and reaccelerate QoQ growth to about 7%. But even then YoY growth would drop to 27%.

The good news is that that’s it as far as not so good news go. Secondary growth metrics came in strong throughout the bench: NRR was at 127%, a percent higher than I expected and really showing to bottom soon as the deltas by which NRR dropped in the last 5 quarters were 9% → 7% → 4% → 3% → 1%.

RPO came in also strong at $5.23b, above my expectation of $5.18b. More importantly, RPO grew an astounding 47.8% YoY, the strongest YoY growth in 7 quarters. Sequentially, RPO grew 4.9%, up from negative 3.6% in Q1 and +3.8% in the last Q2.

Total customer growth was 4.5% QoQ and 21.2% YoY, adding 440 new customers, up from 385 in Q1 and 369 in the last Q2. And while G2000 customer growth clearly points towards reaching some saturation (they now have 736 of them), large customers grew by 5.4% sequentially, significantly faster than my expected 4% QoQ growth and adding another 26 large customers to now 510 customers that spend more than $1M.

Last but not least, Data Marketplace Listings and more than 1 stable edge customer metrics were also, and again, very strong this quarter: The former grew 9.2% QoQ and the latter grew 11% QoQ. With that the fraction of customers having more than one stable edge propelled to a record 34% and the ratio of marketplace listings over total customers reached a record 27%. Here, the growing trends and overall large numbers nicely demonstrate Snowflake’s network effect moat.

So, with all those secondary metrics performing really well, why did Snowflake not grow revenues faster and, more importantly, why are they likely going to continue to slow down YoY revenue growth rates and for how long?

At first I thought it doesn’t make any sense that YoY revenue growth would decelerate in the next few quarters. Just think about it: customers growing 22% YoY and customers from a fixed cohort spent 27% more in the last year than they did in the previous year. And RPO growing 48% YoY? Way above the current YoY growth rate?

Well first, compounding NRR with customer growth rates isn’t that straight forward because the former, in case of Snowflake, is a 2-year backward looking metric and the latter is a forward looking metric. But what about RPO growing at 48% YoY? A big reason for the RPO YoY growth acceleration is customers making larger commitments over much longer periods. That’s reflected in their current RPO which grew 29.6% YoY, more in-line with revenue growth. That said, I don’l think the cRPO metric for Snowflake is very insightful to us because Snowflake is a consumption business, so all that cRPO tells us is what management thinks their customers might consume in the next 12 months. But this is not subscription revenue and therefore not really different from just looking at management’s revenue guides.

So back to the original questions, the only way I can reconcile those secondary growth metrics and explain why Snowflake isn’t going to grow revenues faster in the next few quarters is by looking back at their RPO growth history. Indeed, RPO growth bottomed in 3Q24 at only 23.2% YoY growth. Now keep in mind that RPO is a forward looking metric and we are about to lap 3Q24 when they report next. So if RPO growth at a given time is a reflection of how much revenues are going to grow in the next, say 12 to 24 months (or longer) from now, I think it is conceivable that this is the reason revenue growth will be seeing a slowdown in the next couple quarters. If true, the good, no, even great news is that since this bottom of 23.2% YoY RPO growth in 3Q24, RPO growth has significantly accelerated. This would mean they are bound to reaccelerate YoY revenue growth rates once the effects of the weak 3Q24 have worn off. And they might accelerate quite significantly as RPO growth jumped from 23.2% → 41.4% → 46.3% → 47.8%. Given their current FY25 guide I’d conservatively expect YoY revenue growth to have these headwinds for another two to three quarters where it’ll likely drop to about 26% YoY. I say conservatively because again, Snowflake is a consumption business and new growth drivers, like new AI products can increase consumption immediately. And we might even start seeing this already as “we said before, we have customers that sign long-term contracts. If they have consumed everything under their contract, they have the ability to buy monthly. We have two of our top 10 customers right now that can continue to buy through the end of the year, and we’re seeing that. So they’re in our top 10 customers, and think top 10 customers are roughly in the $50 million or $40 million range. Those aren’t reflected in current RPO very much because they’re just buying as they go”.

A last word on profitability: as expected, profit margins compressed this quarter as Snowflake is continuing to invest in the AI opportunity in front of them. So I am not too concerned here as I believe those investments will pay off later down the road.

So overall, looking just at the declining headline revenue and earnings numbers and guides I am not too surprised Snowflake isn’t (and hasn’t been) faring well with investors, especially those looking at classical valuation metrics. This makes Snowflake a very interesting investment, where investors patience continues to be tested to a point where even the most patient ones might start wondering whether the long-promised growth and profitability will eventually materialize. It is worth emphasizing though that my patience does not rely on hope, but rather on increasingly strong forward looking performance indicators like RPO, customer growth and data sharing trends but also stabilizing NRR. All of those positive trends are framed by a narrative that Snowflake will be a big beneficiary of the future data cloud market, driven by its innovative platform that leverages AI to enable organizations to efficiently manage, analyze and gain valuable insight from vast amounts of data. In there, and maybe also because of current investor sentiment towards “prove it!”, lies an opportunity for significant gains, but also a potential for significant opportunity costs until those gains show up. And as always, it is up to each and every investor in Snowflake to decide to not try to time this and stay invested, or try to find a better place for the money.

Monday:

Key insights:

Monday’s revenue growth has accelerated to over 34% YoY with raw YoY revenue increase showing big uptick and setting them up for strong continued trend going forward.
This was the first full quarter since they increased prices which turned out to be a great decision as gross retention is at record levels despite that, demonstrating strong pricing power.
They raised their FY guide by 1.4% and they’ll likely grow revenue again 34% YoY in Q3, based on guides.
NRR, which was projected to tick up in the second half did even start to increase already this Q2 for the +$100k ARR cohort, while staying stable for the other cohorts.
Strong large customer growth with record net adds, while ARR from those continues to become a bigger part of the pie.
Continued amazing traction with new CRM and Dev products growing 150% YoY and 250% YoY from not such a small base anymore.
Profit margins continued to expand, driven by strong operational leverage.

Monday reported very impressive results for fiscal Q2 2024 on 08/12/24. Revenue was $236M (8.8% QoQ, 34.4% YoY), while I had expected $235M (8.3% QoQ, 33.7% YoY). Beating their guide by 3.6%, they managed to add $19.2M in net new revenue; a new all-time record. As you can see this sets them up nicely for a great growth trajectory going forward:

Here I am showing the raw YoY revenue increase which again displays a post covid bump, followed by a slow down which pretty much all of our companies went through. Now look again at this plot and see how this Q2 made a big difference to the overall trend. This was also the first full quarter affected by their price increase and as you can see it is paying off superbly. Who would have known such a price increase wouldn’t hurt their gross retention and thus limit or maybe even negate any positive effects of revenue growth? And quite the contrary “our gross retention is at record levels”. That tells me that Monday has great pricing power, which, especially for a product like Monday is really great news, because part of my being cautious with sizing my Monday position has always been the question how mission critical and replaceable their offerings are - especially in the coming age of AI. Maybe I underestimated the value of their products even in the face of AI. And maybe, going forward, it will be the AI that is part of their products that will keep them successful for years to come.

Looking forward to Q3, they guided for $245M (3.8% QoQ, 29.5% YoY) at the midpoint, inline with my expectation of $246M (4.5% QoQ, 30% YoY), which I now interpret as $254M (7.5% QoQ, 34.2% YoY), assuming they can again beat by 3.6%. They also raised their FY guide by a healthy 1.4% without raising their price increase impact expectations. This shows management’s confidence in continued product driven revenue growth, beyond any price increases.

Secondary metrics were also great throughout: Net retention rates for 10+ customers, >$50k ARR customers and all customers stayed at the same level as in Q1 at 114%, 114% and 110%. And NRR for >$100k ARR customers increased sequentially for the first time in 10 quarters, to 114% from 113% in Q1. It’s great to see this starting to turn around and I am optimistic that the other cohorts will follow later this year.

Monday also continues to successfully push upmarket with the percentage of >50k ARR and >100k ARR customers reaching a record 33% and 21%, respectively. The former is up from 29% a year ago, 24% two years ago and 12% three years and a quarter ago.

Customer growth was better than I had expected with >$50k customers growing by 8.9% QoQ and adding a record 222 new customers to this cohort. >$100k customers grew by 10.8% adding a record 98 new customers to this cohort. And customers with 10+ users grew 14.6% YoY and is a good proxy for total customer growth as they account for 78% of Monday’s ARR.

Their two new products, CRM and Dev, which are adjacent to Monday’s core product Work management did amazing; again! Priced similarly to the Work Management product, CRM and Dev quickly become new revenue drivers for Monday as the former grew to 20800 accounts, from 17000 accounts in Q1 and the latter grew to 2719 accounts from 2090 accounts in Q1. Certainly significant compared to 57000 customers with 10+ users. CRM accounts grew 150% YoY and 22.3% QoQ and Dev accounts grew 248% YoY and 30.1% QoQ.

On the profitability front, Monday continued expanding its profit margins driven by continued operating expense margin reductions. Especially their S&M expenses which account for 51% of revenues had come down substantially, from 56% a year ago and 70% two years ago. With that, operating income margin expanded to a record 16.3%, up from 9.9% last quarter and 9.5% a year ago and net income margin expanded to 20.9%, up from 14.6% last quarter and 11.9% a year ago. Free cash flow margin was 21.5% and they raised their full year guide for fcf margin to 29% from 26%.

Again, great quarter, just like the previous one.

Axon:

Key insights:

Driven by strong software, sensor and non-US sales, Axon continues to show YoY revenue growth acceleration over last year, pushing growth over 34% and raising their FY guide by 3%, indicating growth durability at around 33% - 34%.a
Sequential ARR growth was weak, but only due to timing, coming out of a very strong Q1 ARR quarter.
RPO on the other hand also didn’t grow strong, despite having been weak also in Q1. My guess is that it’s the same story with timing where most of the RPO action happens in Q4s. At least QoQ growth accelerated from Q1 and is still growing faster than revenue growth at 41% YoY.
NRR stayed constant at world-class 122% and EBITDA margin continued to expand to 24.5%, up from 21.8% in 2Q23.

Axon reported fiscal Q2 2024 on 08/06/24 with revenue of $504M (9.4% QoQ, 34.6% YoY). This was significantly above my expectation of $500M (8.5% QoQ, 33.5% YoY), so we are off to a good start. They also raised their FY guide by 3.0%, to $2.05B or 31% YoY growth. With that, and looking at previous guidance beats, they are well on track to close the year with 33 - 34% more revenue than they earned in FY23. This would compare nicely to 31.4% YoY growth they managed in FY23. Overall, the acceleration is driven by accelerating software and sensor revenue (40% YoY) and non-US revenue (49% YoY), while Taser Revenue (28%) and US revenue (32% YoY) are a drag on growth.

Forward looking performance indicators were mixed, with ARR at $850M and net new ARR of just $25M. But this relatively low number comes after a bombastic Q1 where they got $93M net new ARR, so this might have had more to do with timing than a sudden deceleration. “Yeah, you got it. It’s just timing. (…) I wouldn’t read any more into it than that.”

On the other hand, RPO (total future contracted revenue) grew only 4.5% QoQ, in comparison to 9.4% in the previous year and in this case timing with Q1 cannot be blamed because Q1 was also weak with a sequential decline of 1.5%. Note that bookings are typically heavily weighted towards Q4 when police departments renew their contracts.

The good news on forward looking growth metrics was that their NRR stayed at 122%, which is a very strong number in the current tech-world.

On the bottom-line the strong EBITDA margin of 23.6% we saw in Q1 got even stronger in Q2 and expanded to 24.5%, up from 21.8% in 2Q23.

Let me end with an anecdote:

I had an interesting chat with the “drone team lead” of our local police department (yes, they have a drone team! And naturally, they use Axon body cams and tasers). He told me that they actually already got a waiver to fly beyond the visible line of sight and are currently experimenting with drone as first responder technology. In the US the FAA limits RC drone flight to a radius where the pilot or an observer can maintain a visible line-of-sight to the drone. Obviously that hurdle is a big deal for making drone-as-first responder services practical. But the FAA issues wavers which are called BVLOS waivers and I find it very encouraging that there is at least already one case where such a waiver was issued to a police department for exactly that purpose. By the way, when I asked him about Axon’s new draft one product, which uses body cam video, audio and gps from all officers at a scene, to draft police reports, he told me that he hadn’t heard about it yet and was very excited about such a prospect. He told something along the lines of “for 10 minutes of action in the field we typically need about 6 hours for the bureaucracy that follows.”

Wrap up

I want to end this recap by sharing some thoughts about SaaS as part of our investing universe.

While I make predictions and set my own expectations for the future growth of my companies, there is no way to know how fast DDOG, SNOW, ZS, NET or CRWD will grow in the next few years. Really, there is no way to know how fast any company will grow in a couple years. I think a key of Saul’s approach is to stay invested as long as the growth thesis is intact and get out if it breaks. So yes, some of these companies will slow and some slow-down is just natural for a growing company. The hard part, however, will be to draw the correct line when to get out because growth slowed too much. But ideally by then we’ll already have had new durable high-growth companies identified, into which we already started investing. And as revenue growth slowly drops for those old ones our conviction adjusts to the new ones and so does portfolio allocation (here is hoping that the software IPO market will take off again at some point …). So in my mind this “getting out” doesn’t even have to be a fast thing, but something that can happen gradually, unless of course revenue growth falls off a cliff for some reason …

Speaking about revenue growth falling off a cliff. I think this is exactly how many growth investors interpreted the events of 2022 (and into 2023), and they aren’t wrong, but I think it is important to understand the context of those declines, which came out of two fat COVID years in 2020 and 2021, as I have laid out here: Reflecting on Consensus - #2 by SlowAndFast. The DDOG raw YoY revenue increase plot I have shared in this post tells a much more nuanced story: It tells a story where after COVID many SaaS companies earned revenues very quickly, which otherwise would have been spread out over probably many years - inflating YoY growth numbers. And that got compounded with many SaaS companies being at much smaller scale pre-covid, where growing quickly was much easier. And the plot tells a story where despite that, companies like DDOG have picked up the pre-covid pace again, which is really amazing.

That brings me to another point, which is that I think there are two narrative tailwinds for those SaaS companies in the pipeline. First, I think there is a good chance that every time the FED lowers interest rates going forward multiples will expand, and second, there is a potential tailwind from the new AI era we are getting into which will unlock new revenues both on the data side (monitoring, analysis, warehousing, etc) and security side (new AI related issues like prompt injection, data poisoning and data leakage will have to be addressed). Those two tailwinds come on top of the already ongoing decadal tailwinds of “move to the cloud” and “software is eating the world”.

Finally, since I mentioned it in the previous paragraph, let me share some thoughts about multiples. My thinking here is still very fluid and I haven’t made up my mind about any of this. I might also be completely wrong with some of this. So take it just as food for thought and maybe we can have a useful and friendly discussion that will widen our horizons on this topic. I often hear investors talk about what multiples companies should and shouldn’t have. My thought here is that the market’s “opinion” on what a fair SaaS multiple is, can certainly change with time. Just look at 2020, 2021. And we, on the board were pretty much all fine with those multiples at the time. Who knows what multiples the market ascribes as “OK” in a few years from now? Maybe it is simply the best companies that will get the highest multiples, and the definition of “best” and thus the absolute multiple value will change based on how all other companies are doing relatively to the “best”.

Aside from that, I often refer to revenue growth durability as “king”. One reason for this is that if revenue growth stays constant (say at 25% YoY) and the stock price doesn’t move, that means P/S will compress by ~25% per year and the stock will get cheaper by ~25% per year. With everything else the same, why would that happen if the company keeps delivering durable 25% growth? Especially since this would be a quite a feat that only few companies like Service Now seem to have managed so far. So why would market participants let the stock become cheaper? I think if growth is durable, multiples will be durable (or hell, maybe even expand). Yes, the market has expectations for growth. If you look at what the market expects for all those SaaS companies, it is that growth will decline with time. So I don’t think the market expects these companies to be able to keep their growth for years to come. But if they can achieve that, I expect multiples to expand, which in case of 25% revenue growth should give us more than a 25% return pear year. Of course, it will be critical to be invested in exactly those companies and not the other ones, as many SaaS companies have slowed to single digit growth, but again, we are not investing in any SaaS company. We are investing in what we believe are the best.

But does it have to be SaaS? Well, of course not. But looking at the alternatives my experience has been that it is really, really hard to be successful here. Just look at Enphase (yes, which I still own a sliver of), Aehr, Celsius and Elf, to just name some recent examples. We can make money with those (and I bet some have!), but timing has to be really good, which we all know is incredibly hard. It also doesn’t always have to go this way and there are other examples of non-SaaS companies which have and continue to do extremely well, like Transmedics. Ultimately, success isn’t limited to one approach. It’s about resilience, adaptability, and vision. So going forward I’ll certainly try to keep an open mind and keep looking for opportunities out there. With that I say thank you to all the great posters here for keeping your eyes out and for all your hard work that you are willing to share on this amazing board.

All the best,

Ben

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Fool4ZTribe · September 8, 2024, 2:17pm

Ben, thanks for a very thorough report. I believe your focus on revenue growth is justified and wise. You are one of the great posters on this board and I appreciate your hard work.
Vince

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Ben’s Portfolio update end of August 2024

Ben’s Portfolio update end of August 2024

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